True tax reform requires a new way of scoring
For years, state policymakers have been trying to restructure Maine's tax code in order to get the state on more competitive footing. A standing feature of these proposed reforms has been an insistence on revenue-neutrality, meaning the same amount of revenue must be raised after tax reform as before it. Unfortunately, this position is a major reason why tax reform never gets across the finish line.
Revenue-neutrality doesn't work because under Maine's multiple layers of taxes, it is nearly impossible to create more winners than losers. Special interests that have spent time and money creating their tax loophole(s) aren't going to sit idly by as their tax burdens go up. In the end, the only way to make everyone happy is to ensure that any tax reform results in a net tax cut.
There are two ways to get tax reform and tax reduction to go hand-in-hand. The first, and most obvious, is to cut taxes without any regard to making offsetting increases elsewhere. Gov. Paul LePage's recent cut in the top personal income tax rate from 8.5% to 7.95% is an example of the best kind of tax reform since it is unambiguously good for taxpayers and the economy.
The second, and less obvious, way is to recognize that tax reform, if done properly, will reduce the tax penalty on productive behavior and grow the economy. A larger economy also means higher overall tax collections. As a result of this dynamic economic impact, the tax code can be changed without having to have all the pieces result in a zero impact on the budget.
For example, in FY 2010, Maine's sales tax raised $990 million in revenue which means that at a 5% sales tax rate, every 1 percentage point change increases/decreases tax collections by $198 million. This type of analysis makes no allowances for potential changes in taxpayer behavior. Any sales tax reform would be based, generally speaking, on this kind of static analysis.
However, we all know that taxpayers do change their behavior when taxes change. In regard to the sales tax, many Mainers have changed their shopping habits from patronizing local Maine retailers to shopping across the border in sales-tax-free New Hampshire. As a result of cross-border shopping, any static revenue estimate on changes in the sales tax is guaranteed to be wrong.
Cross-border shopping is not a small issue, either. Based on my recent analysis of retail data from the U.S. Census Bureau, if Maine's border counties had the same level of retail activity as New Hampshire's border counties in 2007, retail sales would have been up to $2.2 billion higher — from $2.9 billion to $5.1 billion — and created thousands of retail jobs. Again, that $2.2 billion retail loss is just for 2007 and compounds year after year. Another way to look at it is that for every $1 spent per person in New Hampshire, only $0.57 cents is spent in Maine.
If Maine were to entirely eliminate the sales tax, the static analysis would estimate the lost revenue of the entire $990 million. Yet, most, if not all, of the $2.2 billion in retail sales lost to New Hampshire would return to Maine. That would mean higher income (personal and corporate) tax and excise tax (gasoline, cigarette, alcohol, etc.) collections. As a result, the actual cost of eliminating Maine's sales tax would be significantly lower.
Unfortunately, Maine's state government does not have any way to make reliable dynamic estimates of tax changes. That does not have to be the case because economic consulting firms such as Regional Economic Models Inc. and the Beacon Hill Institute already have the capacity to do dynamic scoring of tax changes.
One way to institutionalize dynamic scoring is to create a commission similar to the Consensus Economic Forecasting Commission. Having recently been appointed to the CEFC, I can attest to the difficulty of trying to forecast Maine's economy. Yet, it must be done if the state is going to have any kind of roadmap for making important budgetary decisions. A commission on dynamic scoring would build an equivalent roadmap for tax policy decisions.
If Maine is ever going to achieve meaningful tax reform, the current way of doing business in Augusta is going to have to change. The straightjacket of revenue-neutrality must be shed in favor of dynamic scoring for tax changes. Dynamic scoring will give policymakers more options to finally build a tax reform plan that creates more winners than losers.
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